Founded in 1993 by brothers Tom and David Gardner, The Motley Fool helps millions of people attain financial freedom through our website, podcasts, books, newspaper column, radio show, and premium investing services.

When to Buy Dead-Money Stocks

The time to buy is when the business shows more life than its stock.

After the dot-com bubble burst, high-tech companies were largely left for dead. That was for good reason: at their peaks, those stocks had reached incredible heights that were completely unjustified by their financial performance.

The same market that left them for dead, though, forgot to check back later to see if they still had pulses. Not every technology company was ruined when the bubble burst.

Strong company, meet weak stockTech investments were considered "dead money," largely by virtue of just how far those shares had fallen and how long it would take them to recover even a fraction of their past highs.

That might sound fair enough on the surface. Remember, though, that during the worst of the tech-stock meltdown, there were a number of still-profitable technology companies that have since made money for their shareholders, including:

Company

FY 2000
Earnings

FY 2001
Earnings

FY 2002
Earnings

Return Since
12/31/2002

Intel (NASDAQ:INTC)

$10,535

$1,291

$3,117

54%

IBM (NYSE:IBM)

$7,874

$8,146

$3,579

75%

Oracle (NASDAQ:ORCL)

$6,297

$2,561

$2,224

99%

eBay (NASDAQ:EBAY)

$48

$90

$250

49%

Adobe (NASDAQ:ADBE)

$288

$206

$191

235%

Applied Materials (NASDAQ:AMAT)

$2,064

$508

$269

37%

Analog Devices (NYSE:ADI)

$607

$356

$105

37%

*Dollar amounts in millions. Data from Yahoo! Finance and Capital IQ, a division of Standard & Poor's, as of July 31.

That they were profitable even during an industrywide crisis is a testament to their operational fortitude. Even more important, it's an indication that their stocks were still worth something, no matter where they happened to be trading.

The $64,000 questionJust how much they were worth at the time, however, is an entirely different question. After all, while they all remained profitable, as a group they didn't exactly grow their profits over that same time frame. That made it quite a bit more difficult to put a precise value on their true worth, since it so largely depended on when, how, and whether they could turn things around.

But you could have profited even without calling the bottom or predicting the turnaround. You simply could have bought shares in a company whose business was clearly improving, but whose stock still hadn't caught up.

Expectations are everythingYou see, back when the bubble was forming, high-tech companies could do no wrong. Nearly every idea, no matter how kooky the business model or lousy the financials, could get funded, taken public, and watch its share price soar, thanks to very lofty expectations.

When the bubble burst, those same tech companies could suddenly do nothing correctly in the eyes of Wall Street.

No matter how strong the business or how real its potential, when Wall Street sours on a company, its shares tank. Just as extremely high expectations can lead to bubbles, excessively low expectations can lead to irrationally depressed stock prices.

But over long periods of time, the market tends to get it right, as companies' long-run results shape and narrow the range of expectations that look reasonable. On a day-to-day basis, however, current sentiment and current expectations can often temporarily overrule long-run rational pricing.

Where you get your edgeThat interplay between the market getting it right over the long run, but frequently being so horribly wrong in the short run, is the most powerful weapon in your arsenal as an individual investor.

Unlike Wall Street bigwigs who are under the gun to perform every quarter, you can buy when shares trade well below what they're really worth. As the nasty feelings subside, you stand to profit as they return to a fairer value.

Those still-profitable tech companies have all given their investors very respectable returns since the bubble burst. Their businesses survived. Their operations recovered. Their shares rebounded. Time and time again, that's exactly what happens.

History repeats itself with today's meltdownThese days, anything having to do with building, buying, financing, and maintaining houses is in its own doldrums following the bursting of the subprime mortgage bubble. While there have been and will continue to be corporate fatalities from this mess, not every company in the industry will go out of business as a result of it. Yet virtually all their shares have been tarnished by virtue of the industry to which they belong.

At Motley Fool Inside Value, we're actively looking for winning stocks amid the carnage of the housing meltdown. Companies that, like the technology firms that survived their bubble, have the business model, financial strength, and legitimate profit potential to once again shine.

If you'd like to see our favorite companies to profit from today's pessimism, you can try a 30-day free guest pass to Inside Value. Simply click here -- there's no obligation to subscribe.

At the time of publication, Fool contributor Chuck Saletta owned shares of Intel. Intel is an Inside Value pick. eBay is a Motley Fool Stock Advisor recommendation. The Fool's disclosure policy would never leave you for dead.

Author

Chuck Saletta has been a regular Fool contributor since 2004. His investing style has been inspired by Benjamin Graham's Value Investing strategy. Chuck also can be found on the "Inside Value" discussion boards as a Home Fool.